Outlook 2022: Covid and all that

As we head into the third year of the pandemic, Covid will dominate the headlines again in 2022. There are three possible outcomes: things get worse, they get better or they stay the same (how’s that for insight?). Whilst this may be a statement of the obvious, whichever path we are on will have profound consequences for the economy and outlook for financial markets through the course of 2022 and beyond. Since it is impossible to predict how the disease will evolve, it is worthwhile setting out a few scenarios to assess the range of possibilities.

Case 1: The Covid situation gets worse

In the case where a much more virulent strain emerges, we could quickly find ourselves back in the same situation as 2020 with stringent lockdowns and a big hit to the economy. Unlike 2020, however, we will not be facing a totally new threat; we have experienced Covid waves before and the initial reaction from governments will be to impose fewer restrictions than in March 2020. Accordingly, the initial hit to the economy may be less dramatic. But if the emergent strain proves to be more deadly, there will be a significant hit to confidence and the economy may not rebound quickly as people realise that the pandemic is far from over. In such a case, governments and central banks will be forced to open the taps once again, despite the recent surge in inflation, which will continue to put a floor under markets with equities pushing on to new highs.

Case 2: More of the same

A repeat of the 2021 pattern would see a huge rise in cases at the start of the year as the Omicron variant works its way through, followed by a dip during the spring and summer before another less virulent strain emerges in the autumn. Such an outcome would likely mean an uneven recovery with decent but not stellar growth in the spring and summer and a slowdown over the winter months. Covid restrictions would likely be eased in the first half of the year but, as case numbers mount, continued pressure on health services suggest restrictions will be tightened later in the year which would particularly affect sectors such as hospitality as a quasi-lockdown is implemented. In this environment central banks can be expected to ease back on the monetary throttle to curb inflation in the first half of the year but stand pat in the second half, taking some steam out of markets which push ahead relatively slowly.

Case 3: Omicron proves to be the last hurrah for Covid

In the best case scenario, Omicron is the precursor to the emergence of a much milder form of Covid which becomes an endemic problem rather like flu. Economic growth settles towards trend rates and central banks can afford to be more aggressive in tightening policy. However, high inflation in general and rising energy prices in particular will act as a drag on household incomes, with the result that even in this environment GDP growth remains relatively slow. Against that households may run down some of the excess savings accumulated during the pandemic which will act as a growth support. Inflation is likely to slow as supply issues are largely eliminated by end-year and markets lose momentum in the face of higher interest rates and less dynamic growth. We may even start to hear talk of excess supply and disinflation before the year is out.

Politics and geopolitics are back on the agenda

After two years in which the world has been preoccupied with managing domestic pandemic issues, global geopolitical issues are a matter of urgency for western leaders who are increasingly concerned about a more assertive Russia and China. Russian troops have recently been building up along the Ukrainian border and the US has expressed concerns that this could be a prelude to invasion. We have been here before, of course. Last April, Russia built up troop numbers close to the border only to pull back, so latest moves might simply be another chapter in Vladimir Putin’s power play. But they may not, and in the event of invasion there is very little militarily that the west can do in response. The US has talked of unprecedented sanctions, which the Russians would counter by weaponising gas exports. At a time when European gas supplies are in a parlous state, this could have significant consequences for global energy markets.

President Xi Jinping is the most powerful Chinese leader since Mao and sits at the head of a country determined to regain what it sees as its rightful position at the top table. Unlike in Mao’s era it now has the financial and military clout to back up its ambitions. Recent years have demonstrated that China has no interest in living within the strictures of the western-dominated economic architecture, as its behaviour at COP26 demonstrated, and it continues to make threatening noises regarding Taiwan. Unlike Russia, China has no need to throw its weight around to demonstrate its power. But like Russia, it is increasingly seen as a competitor to western interests and the failed policy in Afghanistan, culminating in the shambolic withdrawal in 2021, will only encourage China to press at the west’s weak spots in 2022 and beyond, leading to even more fraught relations.

Here in Europe, Emmanuel Macron will face his biggest test as he gears up for the French presidential election. Despite poor approval ratings, the polls suggest he will easily make it into the second round where he will face a runoff against either Marine Le Pen or Valérie Pécresse, the centre-right candidate of Les Républicains. The polls suggest he can beat either of them in the second round but the pollsters have been wrong before, notably in the German federal election last year which saw the SPD come from behind to beat the CDU into second place. Still, it would be a surprise if Macron were not re-elected to the Elysée Palace in April.

Another leader under pressure is Boris Johnson who faces mounting discontent amongst his backbench MPs. There has been speculation that a leadership challenge could emerge in 2022 which might happen if a combination of failed pandemic response policies and Brexit pain add to existing woes over political scandals. My own view is that Johnson will end the year in Downing Street. Ditching a third Tory leader in six years, before their term is up, will not play well with an electorate that appears increasingly restive, particularly when there is no obvious candidate to replace Johnson.

Markets: More upside but how much is already priced in?

There are good reasons to expect more upside for equities in 2022, albeit not at anything like the 2021 pace. Economic growth conditions remain favourable and earnings are projected to increase at a decent pace. A high inflation environment in the first half of the year may see a rotation towards inflation trades with gold appearing to be a natural beneficiary along with energy stocks. Up to three Fed interest rate hikes are expected in 2022 which may take the edge off equities, but an absence of Covid-related uncertainty would limit any downside.

Crypto will be one of the fascinating areas to watch this year. Bitcoin hit an all-time high above $67,566 in November and although it has since slipped below $43,500 it is too soon to write off the possibility that it can rally back above previous highs. Although concerns about the energy cost of mining persist, and China has recently cracked down on Bitcoin mining, there has been more widespread retail interest of late. Any wobbles in the equity market could certainly see renewed interest in crypto assets as investors hunt for yield. I maintain that the future of cryptocurrencies will depend on the extent to which central banks enter the field, and with the likes of the Bank of England and ECB looking seriously at the prospect of introducing a central bank digital currency, this may well place a floor under any downside for crypto assets in 2022.

What else?

There are a host of other themes that will move the needle in 2022. Environmental issues are one of them and the debate over how to manage climate change can be expected to make its presence felt. This has traditionally not featured much in near-term economic thinking but maybe 2022 will be the year that we pay more attention to the risks. 2022 is also World Cup year. Assuming it goes ahead, the tournament will start in Qatar in November rather than coinciding with the European summer, which will make things interesting. I am not going to pick a winner but with qualification yet to be completed I can confidently state that Portugal and Italy cannot both qualify.

As 2020 showed, unexpected events are the true enemy of forecasting and whatever happens this year, there will be some unexpected events that come out of left field. As Martin Luther King once remarked, “you don't have to see the whole staircase, just take the first step” which is a good way of saying that so long as our forecasts are not outdated before end-January, we can be reasonably satisfied.

2021: Not great but could have been worse

As 2021 draws to a close, it has felt in many ways like a year in the holding pen as we wait for the pandemic to blow itself out. In the western world we have learned to cope with Covid to some degree and even though life is not back to normal the shock value which accompanied the onset of the disease in early-2020 has been conspicuous by its absence. Unlike 2020 when our year-ahead predictions were blown out of the water, an assessment of the predictions made at the start of the year indicates that GDP growth projections broadly met expectations and equity markets continued to power ahead. It was also the first year in four in which we were spared the spectacle of Donald Trump in the White House, thus taking some heat out of global politics. Not everything went according to plan, of course. One thing that was unforeseen was the huge surge in inflation which necessitated the Bank of England doing the unthinkable by raising interest rates.

Another year dominated by Covid

At the end of 2020 things looked grim on the Covid front. A year ago the world had registered 82 million cases and 1.9 million deaths. They got a lot worse in 2021: There are now 287 million registered cases and 5.4 million deaths. These are clearly an underestimate. Europe and North America together account for more than 50% of all cases and deaths, despite accounting for just 15% of the global population. This is largely attributable to better data recording and testing procedures in the developed world as countries with better developed health systems produce more accurate (or more properly, less inaccurate) data. It is also the result of the wilful underreporting of Chinese figures. According to the WHO, China has recorded just 131,315 cases and 5,699 deaths, of which just 1,045 have occurred since May 2020. The epidemiological profession relies heavily on accurate data to model the incidence of disease and project its progress. Fictional data from the region where the disease was first recorded does nothing to help the rest of the world cope with the pandemic.

One of  the great successes in 2021 was the rollout of the vaccine programme. I must confess in autumn 2020 to being somewhat sceptical that governments would be able to roll out the vaccine as quickly as they promised and that it would take until the second half 2021 before needles would start going into arms in a big way. As of today almost half of the world’s population has been fully vaccinated (two shots) with 23% of Europeans and 20% of Americans having received a third booster dose. The vaccine rollout across the EU started more slowly than perhaps it should have but by end-2021 the proportion of those fully vaccinated has caught up with the UK, whose government trumpeted the speedy rollout of its vaccine programme as one of the benefits of leaving the EU (spoiler alert: it wasn’t).

Economy on track but inflation is not

Largely as a consequence of the vaccine rollout, which reduced the extent to which governments were required to lock down their economies, the global economy has rebounded sharply and appears to have suffered considerably less scarring than I anticipated a year ago. After contracting by 3.1% last year, global GDP is estimated to have grown by 5.9% this year and is projected to grow by 4.9% in 2022. Although global GDP is back above 2019 levels, output in the industrialised world is not quite there yet (although US GDP has been above pre-Covid levels since Q2 2021). Nonetheless, compared to expectations in mid-2020, the recovery has been stronger than anticipated and owes much to the actions of governments and central banks in providing fiscal and monetary support.

One of the unexpected consequences of the post-2020 shock has been the huge surge in global inflation. There were suggestions in the early stages of the pandemic that the hit to the supply side of the economy was such that demand would recover more quickly than supply and that there would be a hit to inflation in the medium term. But this was not the consensus view (nor mine). As recently as April the IMF was reporting that inflation would “remain contained in most countries” and projected US inflation in 2021 at 2.3%: over the first 11 months it has averaged 4.5%, reaching a 39-year high of 6.8% in November. The reawakening of the inflationary threat will prove to be one of the major challenges facing monetary policymakers in 2022. I maintain the view expressed in mid-year that the inflation threat will fade but also maintain the view that higher inflation justifies the “case for taking away some of the extreme monetary easing put in place over the last year” – and the Bank of England has duly obliged, unexpectedly raising Bank Rate by 15bps to 0.25% earlier this month. The Fed is likely to follow suit in 2022.

Markets also performed in line with expectations

As predicted, global equities remain the asset class of choice – there really are few places to invest in this low returns environment that will generate the kind of boost that equities are able to give. The S&P500 surged by 27% in 2021 compared with 15% for the FTSE100 and 16% for the DAX. I suspect further upside is likely in 2022 although not at anything like this pace. Bond yields did edge up a little in 2021 in contrast to expectations, with the US 10-year yield up 59 bps on the year, but given the unanticipated surge in inflation that is not such a bad result.

Brexit not yet done

According to Boris Johnson, Brexit was “done” at the end of 2020 when the UK left the protection of the transition arrangements. But as I have long pointed out, Brexit is a process not a one-off event, and it is not going well. I will come back to this issue in 2022 but suffice to say the economic costs are making their presence felt. UK trade flows remain well below their pre-Covid levels whereas German trade has recovered back above these levels. Meanwhile, the OBR calculates that Brexit will cost 4% of output in the long-run versus a 2% hit due to the pandemic. The resignation of Lord Frost as the UK’s Chief Negotiator of Task Force Europe earlier this month, partly over the handling of Brexit, suggests that the process is not delivering what its most vigorous proponents expected. Nor are voters enamoured of the process with a mounting proportion increasingly viewing the vote as a mistake (chart).

Don’t forget environmental issues

For a brief period last month, environmental issues were all over the news as the climate disaster slowly makes its way up the agenda. But governments have not (yet) stepped up to the challenge. The real action on reducing carbon emissions has to come from China and India, with Asia accounting for over 90% of CO₂ emissions since 1990, but neither of them has a plan in place which will limit the rise in global temperatures over the next decade. Those who have watched the film Don’t Look Up, the current big hit on Netflix, will recognise the unwillingness of governments to deal with issues which clash with their electoral priorities. It is not just Asia which has to do more to deal with climate issues: Europe and the US will also need to act, largely because they are in a better financial position to do so. Perhaps what 2021 demonstrated (yet again) is that whilst we all like the idea of saving the planet, we are unwilling to pay the price – both financially and in terms of lifestyle change – to make it happen.

It has not been a great year by any means, but if you are reading this, at least you got through. A Happy New Year to you all and here is wishing a healthy, happy and prosperous 2022

Tree options

After yet another disrupted year with Covid on the rampage once again many people are determined to celebrate this Christmas in a bid to inject some normality into their lives, if only for a few days. And who can blame them? Spare a thought for the hospitality sector, however, which depends heavily on the Christmas party season to generate a large proportion of its annual takings but which has suffered a rash of cancelled bookings and a general collapse in activity. Spare a thought, too, for those working over a period when most people are taking a well-earned break, notably those in the medical profession.

The history of the Christmas tree

One of the most common sights at Christmas are decorated trees which brighten up the gloom at a time of year when most European cities struggle to get more than 8 hours of daylight per day, with Stockholm and Reykjavik managing just 6 and 4 hours respectively. Although decorated trees today symbolise Christmas, they in fact predate Christianity. In Ancient Rome, trees were decorated with small pieces of metal during Saturnalia, the winter festival honouring Saturn, who among other things was the god of agriculture. It has been speculated that the early Christian church adopted 25 December as the celebration of Christ’s birthday in order to tie it to a festival that was already known and accepted by wider society.

Whatever the ancient origins, the concept of an evergreen tree symbolising life in the middle of winter became a well-established European tradition in the centuries that followed, with the modern idea of a Christmas tree originating in the Alsace region on the Franco-German border in the sixteenth century. Tinsel with which to decorate trees was invented in Germany in 1610 (although France became the world’s leading producer by the start of twentieth century). Trees started to catch on in the English-speaking world following the publication in 1846 of a picture in the Illustrated London News showing Queen Victoria, her German husband Prince Albert and their children around a Christmas Tree. In 1850, Charles Dickens’ short story A Christmas Tree described it as “that pretty German toy.” At a time when the UK has a rather convoluted relationship with the EU, it is ironic that many of the trappings of a traditional English/American Christmas in fact originate from Germany. The Germans were ahead of the game once more with the invention of the artificial tree in the 1880s in order to alleviate pressure on natural resources.

Demand has since continued to grow and no self-respecting European or North American head of state’s residence would be seen without a sumptuously decorated Christmas tree. In the United States alone, around 35 million natural trees are now sold each year; the corresponding figure for Europe is around 50 million of which the UK accounts for 8 million. Statistics suggest that two-thirds of UK households opt for an artificial tree with roughly 40% of US households doing the same.

The economics are interesting too

The economics of tree production are particularly fascinating. It takes between six and ten years to produce a natural tree around 6 feet (180cm) tall, so the tree standing in your living room today was probably planted no later than 2015. Producers therefore have to gauge the market up to ten years in advance and also cope with climatic effects which can have a significant impact on the crop. 

In terms of market trends, one of the big issues that tree farmers face is to judge the balance of demand between real and artificial trees. A decade ago artificial trees made up just 10% of the number of trees sold annually in the US – that share has since quadrupled – although in fact the number of live trees sold has remained static whilst the growth in the overall market has been driven by a surge in artificial tree sales. Another factor to look out for are changes in demand for particular variants of tree. In the 1990s, UK demand for Nordmann firs suddenly surged due to the fact that this particular variant is less prone to shedding its needles than the previously dominant Norway spruce. This was a particular problem for growers who were banking on the market remaining unchanged on a six-year horizon. However, those who spent weeks and months after Christmas looking out for pine needles trodden into the carpet now give silent thanks for the introduction of the Nordmann.

As with any agricultural product, unexpected climatic and meteorological events are the things that all growers must beware. Farmers in Oregon, the main production centre in the US, suffered a heatwave this summer which killed off a lot of seedlings in the early stages of development. Fortunately this has not done too much damage to the tree market this year since demand was met from inventory, but a shortfall could occur in 8-10 years’ time if farmers cannot make up for the hit to 2021 production levels. The result has been a modest rise in Christmas tree inflation, according to industry sources, adding to the upward pressure on prices which saw US CPI inflation hit 6.8% last month. Artificial tree producers have also had their problems this year. The bulk of production takes place in China and the rise in global transport costs in the wake of the pandemic has produced a rise of around 25% in US artificial tree prices. Chris Butler, CEO of National Tree Company, reported that “last year we paid $2,000 to $3,000 for containers and this year we’re paying in the region of $20,000.”

Of course, the big question is whether you should go natural and buy a single-use tree or invest in a multi-use artificial variant. Purists argue that there is nothing to beat the smell of fresh pine in the living room although the fact that large numbers opt for the artificial option suggests that for many the downside of jamming the vacuum cleaner with fallen needles outweighs the benefits. The huge piles of discarded trees littering collection points in early January would appear on the surface to suggest that natural trees are very environmentally inefficient. But the balance is a lot more tricky to determine.

According to the Carbon Trust, a 6 foot artificial tree is responsible for about 40kg of greenhouse gas emissions, suggesting that it has to be used anywhere between 7 and 20 times (depending on the weight and the materials in the tree) in order to match the carbon footprint of a natural tree. There again if you are sourcing your natural tree from a long distance away, the carbon footprint of the transport costs will quickly mount up. However, if ownership of a real tree is too much responsibility, you can always rent one for the Christmas period which will then be returned and replanted. Whether this is ecologically sound is a moot point but at least you can feel smug about not contributing to the huge piles of discarded trees that build up at the start of the year.

Whatever kind of tree you choose – or even if you choose not to display a tree at all – it only remains for me to wish a safe and Merry Christmas to you and yours.